AAPL: Pac Crest Cuts to Hold on Customer ‘Saturation’

By Tiernan Ray

Amidst a raft of mixed notes on Apple (AAPL) today, Pacific Crest’s Andy Hargreaves cut his rating on the shares to Sector Perform from Outperform, writing that “the high ends of the smartphone and tablet markets are quickly becoming saturated, which is likely to limit Apple’s growth by pressuring unit volume and driving a mix shift to lower-margin product.”

“We no longer believe the demand environment supports a profit outlook that can drive AAPL materially higher over the next 12 to 24 months,” concludes Hargreaves.

Hargreaves cut his iPhone unit estimates to 145 million for this fiscal year ending in September, from a prior 151 million units, and cut his 2014 estimate to 151 million from 161 million.

He also cut his 2013 iPad estimate to 78.6 million from 84.4 million, while leaving intact a 2014 estimate for 96.2 million units. Hargreaves believes the iPad mini will increasingly cannibalize the regular-size model.

Those changes bring his fiscal 2013 estimates to $170 billion in revenue and $41.85 per share in profit this year, down from a prior estimate for $182 billion and $45.13. For 2014, his numbers go to $177 billion and $43.92 per share from a prior $188.6 billion and $47.40.

Hargreaves sees the market having cooled on cool new hardware, making it harder and harder for Apple to entice buyers into the Next Big Thing with any device, including a fabled television set:

Demand for incremental mobile hardware innovation appears to be waning, which could pressure margins. We believe hardware innovation in iPhone and iPad is quickly surpassing consumer demand. This creates an environment in which substantial inno- vation is likely to be more expensive to achieve, or customers are likely to choose lower-end SKUs and extend replacement cycles […] The crux of our view on AAPL is that we believe the company has already sold iPhones to the majority of global consumers who want and can afford one. Based on figures from the World Bank Development Research Group, we estimate there are roughly 875 million people in the world that earn $15,000 or more annually, and we estimate just over 25% of them were using iPhones at the end of C2012. Although we believe Apple can continue to grow its user base, we expect sales to new users are likely to decline significantly going forward, which is likely to limit total iPhone unit volume […] In our most recent carrier checks, we noted two key pieces of evidence that support our belief that the high end of the smartphone market is becoming saturated. First, sales of heavily discounted Android handsets in Europe were outperforming our expectations while sales of the iPhone were underperforming our expectations. This suggests that the incremental buyer does not have the capacity or desire to purchase a higher-end handset with a more expensive data plan. Second, iPhone 4 and 4S inventory in the United States was depleted while iPhone 5 inventory was in line with our expectations. This suggests the incremental iPhone buyer is more likely to purchase a lower-margin device than either we or Apple anticipated.

Hargreaves sums up what he thinks is an “unrealistic” sense of how many people can buy an iPhone by plotting this chart of future sales of the iPhone against total iPhone user count, which would have 375 million users of the iPhone at the end of fiscal 2014, which would be “43% of the total number of people in the world who make over $15,000 per year, which is an unrealistic expectation in our view”:

The fair value of the stock is $440 to $550, writes Hargreaves, given a “lack of material growth opportunities,” plus the risk of any “lower retention rates among iPhone users or incremental gross margin pressure.”

Hargreaves explains his valuation reasoning:

A multiple of 5.0x EV/EBITDA, using our F2013 EBITDA estimate of $58.4 billion and tax adjust- ing foreign cash holdings, would suggest a forward-12-month fair value for AAPL of $440. 10.5x our F2013 EPS estimate of $41.85 would also suggest a forward-12-month fair value of $440 [...] On the upside, we believe continued strong demand for iPad and a modestly improved overall profit growth outlook exiting F2013 could support multiples that are on par with where AAPL traded exiting 2012, which was around 13x trailing-12-months EPS and 6.8x EV/EBITDA. 13.0x our F2013 EPS estimate of $41.85 suggests a 12-month fair value of $545, while 6.8x our F2013 EBITDA estimate suggests a fair value of $555. The average of these two suggests up- side to $550 based on our current estimates.

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There are 14 comments

JANUARY 16, 2013 12:37 P.M.

Falcon wrote:

Continuing to insist that Apple is just another drub company deserving drub multiples is unrealistic in our view, as it amasses the largest cash balances in the history of business.

When you give FB, NFLX, AMZN et al drub multiples as they struggle to be profitable, then your analysis will be worth reading.

JANUARY 16, 2013 12:43 P.M.

John wrote:

Think long term. Walk around several college campuses and see what laptops and other products the students are using. These are the business leaders of tomorrow, and what they use now will prejudice them for decades to come. There are a lot more Apple products than expected by usual statistics.

JANUARY 16, 2013 1:09 P.M.

Bad Math wrote:

Where is the CASH in the calculation?

JANUARY 16, 2013 1:20 P.M.

Anonymous wrote:

disagree on the price target and most of article, but agree that innovation is getting less bang for the buck, the iphone 5 had lots of innovations, from SoC chip design, camera lens, metal body, that just gets lost on consuemrs Given the popularoty of GS3s and larger phones it's clear taht consumers are interested in one thig: bigget phone for the buck. i hope that is a message Apple is taking to heart.

JANUARY 16, 2013 1:57 P.M.

Bill wrote:

Another dope heard from. Customer Saturation my ass.

JANUARY 16, 2013 2:08 P.M.

Bobby wrote:

Who is this clown?

JANUARY 16, 2013 2:13 P.M.

Jake_in_Seoul wrote:

Saturation? The party is barely beginning in China, even without China Mobile. Meanwhile in Japan hordes of customers are reportedly defecting from the market-leading Docomo network for Softbank to use iphones.

Meanwhile, in an article that will never appear in the WSJ, a reporter for Sina Tech News looked at the volume of exports of iphones exported from Henan Province in China (site of the massive Zhengzhou iphone 5 factory) and learned:

Which I would translate as: "Recently has come news that component orders in the supply chain were reduced by half. Apple shares crashed below the $500 barrier. But this reporter found that based on the relevant statistics iPhone 5 shipments remained relatively strong domestically."

In short, data from China does not support the WSJ thesis of declining interest in the iPhone that has been so effectively trumpeted from every available media outlet globally.

JANUARY 16, 2013 2:14 P.M.

Victor wrote:

As expected, yet another clown coming out to try forcing the stock down in order not to pay out to the Friday option expiry. You bunch of greedy pigs!

JANUARY 16, 2013 2:27 P.M.

Paulo Lin wrote:

Was obviously going to come back some after a 2 day >6% loss! My guess, tomorrow is short day again :-) The earnings are not out yet, my prediction, way below expected.

You guys don't get, Apple is like the Palm, cool for a while until better and cooler come knocking at the door. Unlike the ipods that took control of the MP3 market, now practically obsolete, Google Android is a strong competitor and has now taken the lead with more Apps than Apple. Not just more Apps but more free Apps which means more happy consumers which means less happy consumers for Apple products. Honestly, the price gouging has caught up to Apple. How can they get away with charging $100 more for an iPad mino because of 16GB extra memory when all other competitors with superior products such as the Google Nexus 7 (rated better than ipad mini by CNET) charges $30 more for the extra 16GB. Until Apple decides to cut their MEGA profits, the stock will go down because their market share will decrease as it is starting to now.

JANUARY 16, 2013 2:57 P.M.

Brent wrote:

Forget WSJ, Barrons, Cramer, Cnbc, and
All the Analysts and Media types that have
an opinion on Apple. The only one that
you need to follow is Tom Demark. Every
Top Hedge Fund Manager and Billionaire
trust this guy 100% of the time. Tom came
on TV last night, which he never does, to
set the record straight on Apple. He called
the high in September and last night
called the bottom at 494. Tom in 5
minutes put all these clowns in their place.
He quite confidently and without hesitation
said, Apple hits 600 in 7 days! He is already
20 points closer to 600 from last night. Take
it to the bank, Apple crosses 600 in 6 days!!

JANUARY 16, 2013 3:00 P.M.

Paulo Lin wrote:

LOL, good luck, down tomorrow, garanteed!

JANUARY 16, 2013 3:59 P.M.

ziggy wrote:

I'm almost the opposite of an Apple fanboi but I do have to say that if these analysts think that Apple has no growth opportunity than they likely also believe that the United States is an island in the centre of a flat Earth at the centre of the solar system to which the entire Universe gravitates around. If they could see that the Earth is in fact curved to an elyptical shape they'd be able to see China on the horizon... A much larger market than the United States which has barely been penetrated and yet they sucked something like $15B out of it last year!

JANUARY 16, 2013 10:08 P.M.

Peter Gittlin wrote:

Tim Cook said he believed China would surpass the US as Apple's largest market. He wouldn't have said that if he didn't believe it. They have barely scratched the surface in China with Mac Computers and Ipads as well as Iphones. Also much of Latin America, India and many other countries do not yet even have 1 Apple store. An Apple TV, mobile payment, home automation, car telematics, there are many markets Apple could enter. Unfortunately the analysts are unable to see any vision for the future. One thing Apple should have done though is come out this year with a 4.8 inch iPhone, a phone with an NFC chip, a lower priced Iphone for the Pre-Paid market and multi colors on the Iphone. Also the iOS needs to change to become more stimulating like Windows Tiles and Android. The market is moving fast and Apple needs to match these features and add features before other brands so they can keep the innovation title for Phones.

JANUARY 17, 2013 8:17 A.M.

Paul Reid wrote:

Obviously you clowns don't understand the Chinese market. If you remember correctly the state itself sponsored the development of a ripoff of the Windows operating system, because they didn't want to pay Windows licensing anymore. Open platforms and free software drive the Chinese marketplace. These zipperheads do not want and will not pay for software. The iPhone, App Store, iOS, are all CLOSED platforms, and you pay for everthing, every app, period. Android, Linux, anything but pay to play software. You are all drunk if you think China will save Apple.

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.